Monday, March 09, 2009
credit takes a turn for the worse
but i think the more important insight as to why might be better seen from the perspective from james kwak at baseline scenario.
... for the last five months, the government has been doing everything it can to imply that bank creditors (at least for “systemically important” banks) will be protected, without saying so explicitly, because that would suddenly increase the potential liabilities of the government by trillions of dollars.
So what changed this week?
Simon’s theory is that the semi-forced conversion of Citigroup preferred into common shares was taken as a sign that the government may try to force creditors to exchange their bonds for common stock in future bailouts. Preferred shares are not, technically speaking, debt. But they are a lot like debt, and once you finish converting preferred into common, the next layer of the capital structure is subordinated debt. Now, Tim Geithner could come out and say, “Yes, we forced a conversion of preferred into common, but we’re going to stop there and not do the same to creditors.” But no, actually, he can’t say that, because that would constitute an explicit guarantee of all bank liabilities. So the market is left wondering, and we know by now that markets don’t like uncertainty.
Another possibility is simply that more and more people are thinking that the government may end up restructuring debt. Martin Wolf and Willem Buiter, both very serious people, both have raised the question of whether the government should be protecting creditors. Wolf, I believe, doesn’t answer the question (although he discusses the issue very well); Buiter says no.
Each time the lines on that chart above have spiked upward, the government has taken some action to imply that creditors will be protected, without making any promises. Chances are we’ll see another action along those lines. At some point, though, the government may lose credibility.
simon johnson earlier said:
In a comprehensive systemic clean-up approach and complete recapitalization approach, debt-equity swaps could potentially play a sensible role, particularly in countries without the fiscal capacity to sustain guarantees of all bank liabilities. But if they are done in chaotic crisis mode - as the government appears to be signalling - the additional damage to confidence around the world will be huge.
The events of mid-September 2008 were traumatic and awful to behold. I saw that trailer and I don’t want to see the movie. But it is exactly into that scary future that we now head.
UPDATE: the plunge is continuing.
UPDATE: and continuing:
... [O]ver the past day, the financials senior debt CDS index has been trading wide of the main Markit iTraxx Europe index, which has happened only twice before, according to analysts at BNP Paribas — the first time in March 2008, when Bear Stearns was taken over, and then in September 2008, when Lehman defaulted. A note to BNP clients declared:The crossing is clearly not a healthy sign, and is reflective of a rise in systemic stress; in the past, it only lasted for a short period of time…However, going forward , we expect that the decompression between senior financials and the main could persist as solvency concerns leads to some degree of haircut for senior bondholders…a fact being reflected in cash bonds over the past month.
more from zero hedge.
UPDATE: more from the ft.